It always seemed to me that traditional banks tend to make most of their money on the backs of people that pay penalties for small errors rather than just charging for capital as their business model might otherwise suggest. Credit card companies seem to be doing the same thing, jacking rates to the maximum allowable limit if their customer goes late on a payment. All of this makes it look like the traditional banks and credit card companies are making money by being deliberately opaque, hiding their true cash cow of fees in fine print.
The peer to peer lending market has been exploiting the opportunity this opacity creates. Who would have thought these peer to peer lending sites had a chance against traditional banks? But borrowers and lenders warm up to them because they strive to become as transparent as possible.
But why do I have to get a loan for a specific need like an addition to my home? I don’t get a credit card for a particular need, its just so I have it if I need it. The reality is that the current peer to peer lending market is uncollateralized. I can’t go hold a chunk of a house ransom if a borrower doesn’t pay me back for a home improvement loan I gave him. I can’t “repo” the motorcycle I helped that guy in Utah purchase if he defaults, so what sense does it make that these are specific loans for specific goals? I’m merely making uncollateralized loans to individuals for whatever purpose they want. Its really just a bet on the person’s credit rating and “confirmed” financial situation.
So why couldn’t we think of it more like revolving credit? Why couldn’t I get a Visa or MasterCard from a P2P loan site instead? The P2P lending company would sponsor the process issuing a credit card to borrowers funded by lenders pooling their money. Adding to the existing P2P loan benefits, the lender makes more money because revolving credit interest rates are higher than “standard loans” and the borrower has much more clarity into the factors that can make his APR go down and credit limit rise over time.
Since there is no one purchase the borrower would be arguing for in their loan application, their listing would be a generic revolving credit application. Lenders would fund slices of the pool the borrower sees as available credit and the APR and size of the credit pool would be the principal negotiating factors when setting up the account. Over time, as the borrower proved a good repayment reputation, a “credit review” would automatically go up for bid again, potentially increasing his credit limit and decreasing his rate.
This would make the peer to peer lending market a little bit more realistic. P2P loans are generally uncollateralized, just like revolving credit. Give borrowers an easier way to access their P2P credit by issuing credit cards and lenders will make more money without a change in risk. Both will benefit from a much more transparent process.